In a volatile property market buffeted by the effects of coronavirus (COVID-19) and the stamp duty land tax ‘holiday’, John D Bunker and Elizabeth Pearson examine the implications for post-death gains
Many tax issues in estates have arisen from the volatile property market, with losses in value due to the COVID-19 pandemic, the effect of the stamp duty land tax (SDLT) ‘holiday’ (to 30 September 2021), and the change of working lifestyles for many. Although some locations have suffered from the move away from cities to towns and the country, for many estate practitioners the big issue has not been properties selling for a loss, but post-death gains. ‘Quality of life homes’, with access to fresh air, and sea or country, have often sold at well over the probate value (PV).
We will explore this to consider:
- the alternatives of inheritance tax (IHT) or capital gains tax (CGT) on post-death gains, and
- the interaction of IHT loss relief and CGT where there are both losses and gains.
1. Has the probate value of the property been ascertained?
Section 62(1) of the Taxation of Chargeable Gains Act 1992 (TCGA 1992) provides that the personal representatives of an estate (PRs) are deemed to acquire property at the market value at death. The PV then forms the estate’s acquisition cost for CGT purposes, if the value has been ascertained (section 274), where the value is used in assessing an IHT liability, or is otherwise agreed by HM Revenue & Customs (HMRC).
The PV is not ascertained if the value is simply reported in an IHT account but is not needed in practice. Many IHT205 forms were completed for deaths up to 31 December 2021, before the new rules for excepted estates for deaths came into force from 1 January 2022, where no IHT was payable. In that case, if there is a later sale at a gain, the PRs are free to negotiate the value on the date of death.
Example 1
Ravi is divorced and leaves his property, along with £30k of other assets, to his three children. With a nil-rate band and residence nil-rate band (RNRB), totalling £500k, no IHT is payable when you arrange a valuation of £400k for his house. When it sells for £450k, it appears to be a gain of £50k, but the £400k figure was never ascertained.
You can therefore propose that the PV be revised, and it may be that the facts support a value at the date of death of £450k. This would make the total estate still less than £500k, so no IHT, or CGT, is due. This depends upon all the facts and factors discussed under headings 4 and 5.
Say the facts show a real increase in value post-death, and that a £50k gain is hard to avoid, you may be able to split the gain for example into four shares, with each of Ravi’s three children having one quarter, and the final quarter in the estate, each with a £12,300 annual exempt amount (AEA) (assuming otherwise unused).
Do note the IHT405 form, where an IHT400 is required, asks about sales made or intended within a year of death, and whether the PRs want to use the sale price as the PV. This can be helpful in cases such as Ravi’s above, but be careful if saying ‘yes’ cuts across planning (this is discussed under heading 5).
2. How good was the original ‘valuation’?
IHT is payable on the open market value of an asset at the date of death (sections 5(1) and 160 of the Inheritance Tax Act 1984 (IHTA 1984)). The HMRC’s IHT toolkit has invaluable guidance on the potential risks and how to mitigate them, based on experience of what goes wrong.
HMRC warns: ‘Valuations are the biggest single area of risk, accounting for a large part of HMRC’s compliance checks… For assets with a material value you are strongly advised to instruct a qualified independent valuer, to make sure… for land and buildings, it meets Royal Institution of Chartered Surveyors (RICS) or equivalent standards. Some issues are easily overlooked when instructions are given. For example, the potential for the development of the land – in other words, hope value.
Unless you have a property with no prospects for development (for example, a purpose-built flat, or new terraced house with a small garden), always ask valuers to refer to hope value in their report. Even if development seems unlikely, it helps to cover yourself in case, say, where there is a re-development planned within a year. Relaxed planning regulations mean permissions can allow for knocking down buildings, to build them back better than before, or squeezing an extra property onto a bit of garden.
3. Appropriation: a crucial concept you need to get right
One crucial power in a will which is often taken for granted – whether an express power or extending the statutory power – means PRs don’t need consents from residuary beneficiaries to appropriate assets to a beneficiary or trust in whole or part satisfaction of an entitlement to a legacy or share of the estate, rather than selling everything.
PRs’ legal duty to satisfy legacies, and divide the estate fairly, means appropriating at market value (MV) at the date of appropriation, not at PV.
However, the beneficiary acquires the asset (that is, a share of property) at PV for CGT purposes and, once done, PRs hold the asset as bare trustees for the beneficiary or trust fund. This means that income and gains arising from the appropriation date are personal (or trust) income and gains. This is important both for deductible benefits (see 4(3)) and especially loss relief claims (see heading 6).
Forms of appropriation only need to show details of the interest being appropriated, with two values – the MV for appropriation and the PV for CGT – that must be signed and dated before any sale. You can’t do it after the event, which for property means before any exchange of contracts.
4. What happens if you sell a property soon after death at an increased price?
With a sale soon after death (or after marketing for a short period) at a higher price than valuation, HMRC can suggest the valuation was too low and you should substitute the sale price – but be careful of potential interest and penalties on any underpaid tax! The onus is then on PRs to show the original valuation is correct and the increase reflects changes in the market or to the property. If you can show a change in value, the estate could be liable to CGT rather than IHT on the increase.
Capital gains are always better than IHT, for four reasons:
- Lower rates: CGT is a maximum of 28% (including the 8% surcharge), rather than 40% IHT (though watch for cases with a 10% or 15% discount).
- Annual exempt amounts: these may be available for the PRs (in the year of death and two more tax years) and for beneficiaries, to offset gains.
- Split up gains: You may be able to split up the gains by appropriating shares to different beneficiaries, who may have their annual exempt amounts and lower rates for any gains. (Take care to flag to beneficiaries the effect on SDLT, such as potential loss of first-time buyer relief by having owned a beneficial interest in a property.)
- Deductible expenses: You are able to deduct some expenses against a gain for CGT, including agent and solicitor’s fees, and in some cases an allowance for the cost of obtaining probate.
In many cases, there may be a split, with some increased value down to a low probate figure, and some due to improvements (see heading 5). A proper valuation (see heading 2), not an unrealistically low one, is important. This may need stressing in instructions.
The practical compliance problem is that PRs (and/or beneficiaries, if a share is appropriated to them) must pay their CGT on any residential property gain within 60 days of completion. Payments on account may be needed based on your assumptions, with clients warned of possible increased tax if it proves to be more IHT and less CGT.
Example 2
Uncle Sam dies, leaving his estate to nephews Ben and Jerry. The White House is valued for IHT at £1m but sold at a loss of £100k for £900k; whereas Sam’s country home Rose Cottage sells for a £50k gain after nine months, for £300k rather than a £250k PV, due to improved value reflecting market changes. If Rose Cottage were sold by PRs in the estate it would lose £50k loss relief, with £20k more IHT. If Uncle Sam’s PRs appropriate Rose Cottage to Ben and Jerry equally, to sell as bare trustees, this gives the nephews £25k capital gains each, preserving the estate’s full £100k loss.
Ben and Jerry each set off half the sale expenses, and their own personal £12,300 annual exempt amounts, and pay CGT on the balance at 18% or 28%. It’s always better to pay CGT, rather than 40% estate IHT, but make clear they both have actual CGT to pay, within 60 days, and seek their approval to extra fees.
5. Planning ahead for the two main potential reasons for claiming a capital gain
Managing client expectations in selling a property is important, and professional advisers can be proactive in helping clients mitigate their ultimate tax burden. You need to get your preparation right. Don’t forget PRs are self-assessment taxpayers, who report the tax they consider payable, but may then be required to produce evidence to justify figures. Good prep helps get the compliance and tax-planning right!
(1) Market change: a good valuer, with local know-how and experience of this type of property, will have expertise in what affects value, and experience of other similar cases, if needed in negotiations with HMRC. It’s helpful if the valuer sees the property early on, especially if any improvement work is being done.
(2) Property improved by works: where work is to be done to improve the condition before a sale, it is important the valuer sees it beforehand. Take photos before the work, to show the effect of the works.
The extra value added to a house simply through having a new kitchen and good decor can be significant, and helps to show it is a capital gain post-death, due to improvements, not more IHT being due. A bonus is that the improvement costs are a tax-deductible expense, to further reduce the taxable capital gain.
So, there is scope to be proactive, plan for the better tax treatment and add real value. You need to get the right valuations and offer additional planning advice to secure tax benefits. Do give PRs / beneficiaries choices – on tax saving and your tax advice costs. This can be skilled work, not to be underestimated, and if this is not factored into your original quote, may need approval from the client for extra fees. It helps if you can show the work that has to be done – and the extra planning, with the potential value added. such as gains post-death potentially subject to CGT not IHT.
6. Loss relief for IHT – for land
Where estates have both losses and gains post-death, consider the interaction of IHT loss relief and capital gains. Section 191 of the IHTA 1984 allows loss relief on land in the four years from death. When claiming, PRs must include all sales by ‘appropriate persons’, that is PRs or the persons paying the IHT, acting in the same capacity. So all sales of land are included, not only losses, such that gains will reduce loss relief. All these sales must be shown on the IHT38 form, which sets out important questions to be aware of, such as selling at less than the best price possible.
The solution to this waste of loss relief is to arrange any sales realising losses by appropriate persons, in other words, PRs acting in the same capacity, to secure loss relief; but arrange any sales with gains outside the estate.
The key is appropriation (see heading 3). Assets appropriated are outside the estate for any sales. If PRs realise gains post-appropriation, as bare trustees for beneficiaries, those gains don’t reduce the losses, maximising relief. If selling land with losses and gains, sell assets with losses in the estate, within the loss relief time limits, and realise gains post-appropriation as bare trustees for the beneficiary.
In practice, be careful with appropriation costs, so that your extra fees for advising and preparing a form don’t exceed the tax saving. A simple cost / benefit analysis helps clients approve the extra work with reference to potential benefits. Secondly, all residential property sales must factor in the 60-day CGT payment required. If appropriating to a beneficiary, they may need help to report and pay CGT, and this compliance cost should be considered in any choices.
